Bankers began to wring benefits from mergers and cost-cutting campaigns in the first half, easily offsetting an uptick in problem loans at the largest banks.

According to American Banker's statistical snapshot of the 58 banking companies with more than $10 billion of assets, return on assets increased on average to 1.38%, from 1.35%, and return on equity grew to 18.06%, from 17.69% in the first half of 1997 (Complete tables appear on pages 8-10.)

The 11 thrifts in the same size category also saw improvement, with return on assets growing on average to 1.22%, from 0.88%, and return on equity improving to 17.90%, from 16.90%.

The performance demonstrated bankers' growing skill at managing balance sheets, analysts said.

Banks are deploying their resources more effectively, said James M. Schutz, banking analyst at ABN Amro. "Revenue growth remains pretty solid, especially in fee income, and banks are doing a good job managing their capital."

Those measures bode well for coming results, although analysts warned that credit quality is likely to become a larger issue.

"Things can't remain this good forever," Mr. Schutz said.

Banc One Corp. demonstrated that a combination of acquisition acumen and focus on fee income can pay off by earning the best return on average assets among "megabanks"-those with $75 billion or more of assets-at 1.69%, a stark contrast to a mid-1997 figure of 0.77%.

The year-ago ratio was hit by a $328 million after-tax restructuring charge Banc One took in connection with its purchase of First USA Inc. But now this and other integrations are paying off, said Banc Once vice president Jay Gould.

"We have a higher-return credit card business, solid consumer finance operations, and fee-income operations," Mr. Gould said.

Bankers say that having analysts and investors increasingly looking over their shoulders makes improving performance ratios more important than ever.

For instance, this year Fifth Third Bancorp has closed its two biggest acquisitions and still finished solidly among its peers, a performance that pushed its share price up.

The stock-price premium positions the institution to use its higher valuation and efficiency skills to make more purchases that immediately add to earnings.

The data show an increase in problem loans for those banks with $75 billion or more in assets, giving credibility to concerns by regulators that lending standards may be slipping, analysts said.

For the entire group, however, problem loans slipped to 0.76%, from 0.79%.

Domestic lending has become so competitive that banks are cutting prices, and in some cases they may be cutting corners, which would boost loan losses in the future.

In some cases the increase in nonperforming assets is tied to contract arrangements with counterparties, especially in Asia.

For instance, reflecting the impact of being on the wrong side of derivative contracts with Asian counterparties, Bankers Trust Corp. saw nonperforming assets jump to 4% of outstanding assets, compared with 2.70% for the same period in 1997.

Bankers Trust also saw a decline in return on assets, to 0.48% from 0.65%, and lower return on equity, to 14.40% from 15.20%.

In addition to loan-quality issues and competitive pressures, banks face challenges to their net interest margins.

The margins-the spread between what is earned on assets and what it costs to carry them-continue to decline. The cause: pricing pressures, reshuffled asset-liability mixes, and higher funding costs, analysts said.

Add to this an industrywide decline in loan demand that some analysts project, and banks could find themselves scrambling to maintain margins.

Still, there is no specific formula to ensure robust margins.

MBNA Corp., as a giant in the unsecured credit card business, has more nonperforming assets than other financial institutions.

But the company delivers, producing the highest return on assets and return on equity among institutions with $10 billion to $25 billion of assets.

"We focus on fundamentals," said Brian Dalphon, senior executive vice president at MBNA.

"It's a matter of getting the right customer and keeping that customer," an approach that benefits both the company and its clientele, Mr. Dalphon said.

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